Lloyd's ensures its own future

Two years ago the world's biggest insurer faced disaster, but radical reforms have pulled it back from the brink. Grant Ringshaw reports

Just under two years ago Lloyd's of London, the world's biggest insurance market, appeared to be heading for meltdown, yet again.

Lloyd's was facing its largest ever single loss, following the September 11 terrorist attacks. And there were signs that the market was powerless to prevent billions of dollars in new underwriting capital flooding to rival insurance centres, such as Bermuda.

Would this, at long last, be curtains? Certainly, Lloyd's was back on the brink of disaster, after eye-watering losses totalling £7bn between 1997 and 2001.

But the 316-year-old market has made a habit of staring into the abyss and then somehow pulling back again. Thus Lloyd's was reconstructed after it nearly collapsed in the mid-1990s, following losses of £8bn related to asbestos and pollution claims.

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Through the decades, Lloyd's became locked in a vicious cycle, swinging from immense profits to heartbreaking losses - boom to near-bust - every five or so years. It had to stop before one of the downswings became fatal. And, just possibly, the ebb and flow has become less dramatic.

Why the cautious optimism? Well, in the past 18 months Lloyd's has pushed through a series of controversial but necessary reforms.

Last September it won the backing of its members for a "franchise" system that will crack down on poorly performing underwriting syndicates. It has also set out plans to move to annual accounting in 2005, replacing its arcane three-year accounting policy.

What's the importance of these governance changes? Nick Prettejohn, the chief executive of Lloyd's, says: "The extremities of performance we had in the second half of the 1990s were testing the patience of capital providers and investors".

Others have put it more starkly. Without the changes, Lloyd's would have been "condemned to a future of increasing insignificance", says Rolf Tolle, the insurance industry executive who was appointed to head the new franchise board at Lloyd's last December.

Much of the credit for the reforms goes to Sax Riley, who stood down as chairman of Lloyd's last November and died last month. Riley drove through the reforms in the teeth of deep-seated misgivings among Names, the individual investors who traditionally supplied the market's capital.

Their concern centred on the tough powers of the franchise board to scrutinise the business plans of the market's 71 underwriting syndicates, as well as those of the managing agents - which represents a huge cultural change.

Other measures included the power to force syndicates to put up more capital and impose strict guidelines on an insurance portfolio. Sanctions range from suspending a syndicate - a measure that has already been applied to three underwriters - to ejection from the market.

To underline the tough new approach, Prettejohn took the unprecedented step in June of naming and shaming the syndicates that had made calls on the Central Fund, the pool of money which is ultimately used to pay compensation when a syndicate is unable to cough up.

Prettejohn, in an interview with The Sunday Telegraph, describes the claims on the Central Fund, which amounted to £508m in 2001 and 2002, as "unacceptable, unsustainable and not repeatable".

The 43-year-old former management consultant (he was at Bain for almost 10 years) is a nitty-gritty businessman. "He is is not really a leader," says a senior insurance industry executive.

The gravitas and flag-waving are provided by Lord Levene, the veteran industrialist, former investment banker and erstwhile government fixer [and a former Lord Mayor of London], who took over as chairman last year.

Their joint message is that Lloyd's is finally on the front foot. But so it should be. Conditions in the insurance market - with premiums on a sustained upward trend - are as benign as they have been for years.

The question, therefore, is whether this is just another upward phase in the cycle or whether something more fundamental has changed. Levene takes the more optimistic line: "The fact is that I inherited a modus operandi, pushed through by my predecessor, and that is how we will do business. And it is proving very effective.

"Now," he says, " I would say that, because the market is in such good shape. But I believe we will get to where we want to be, rather than go through these horrendous peaks and troughs."

But the real test will come in a downturn. "When the market goes down we have to avoid these thunderous losses," he concedes. "The singular success will be for Lloyd's to make a modest loss or even a profit when the cycle turns down."

After racking up a loss of £3.1bn in 2001, including a net loss of £1.98bn to cover the World Trade Center attacks, Lloyd's actually made a profit of £834m in 2002.

So, amid the doom and gloom among some insurers, which has included a profits warning from AIG, the world's biggest insurance group, Lloyd's looks in relatively good shape.

Prettejohn argues that Lloyd's has "taken the pain earlier" than many rivals and was one of the first to identify the true scale of the losses in the insurance market in the late 1990s.

"We were criticised roundly at the time for our losses," he says. "But lo and behold, it now turns out that things were a lot worse than many predicted. We will see more people [rivals of Lloyd's] having to make extra capital reserves."

However, although Lloyd's increased the amount of business it can write this year to a record £14.4bn, Prettejohn says the priority is not to take market share. "I am not terribly interested in market share. What we need to be interested in is underwriting for profit.

"The insurance industry and Lloyd's are littered with businesses that have been undone as a result of pursuing premiums rather than profits. It is a cardinal sin. That is the most fundamental lesson of the past. I think pursuing market share is a very dangerous policy."

One concern is that the franchise system, or the imposition of more central control, could damage Lloyd's ability to innovate. After all, the market made its reputation as an insurer of risks that more orthodox underwriters wouldn't touch.

Prettejohn says Lloyd's faces a "critical balancing act". But he adds: "The last thing we want to do is lose one of our main assets - the ability to respond in a much more agile and nimble way than large companies can."

Meanwhile, Levene has delivered a tough message that Lloyd's is not punching its weight in Europe or in parts of Asia. Europe accounts for 30 per cent of the global insurance market, but just 13 per cent of Lloyd's business.

So he has been selling the Lloyd's story around the world, most recently in China, where the market may gain a licence to create an onshore reinsurance branch (after intervention from Tony Blair, the prime minister).

Also, Lloyd's still has a reputation for being expensive and bureaucratic. Levene has repeatedly condemned the paper-based system that the market still uses as "antiquated".

Proposals for a new accounting practice are grinding through the system and could save £50m a year.

"I should not get into a lift at Lloyd's and be accompanied by people carrying files above their heads," says Levene. "What we are trying to do is not rocket science: it is what every company already does. Where we are now is ridiculous."